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Finding Value Stocks? Make Sure You Consider PEG Ratio

Volatility in the stock market has steadily increased over the past year with several macro-economic issues hitting investors’ portfolios without any prior indication. Whether it is the oil price plunge, the Fed rate issue, a controversial political statement or weaknesses in China, an investment portfolio is vulnerable to sudden shifts in the market.

With volatility at a high, it is important for investors to not only understand but regularly use the technical tools to better brave adversities.

Against this backdrop, we would suggest considering PEG (price-to-earnings-growth) ratio, a not so commonly used but very important valuation metric, as one of the key metrics for stock selection. PEG helps finding a stock’s intrinsic value better than the commonly used ratios, as it considers the rate at which a company will grow its future earnings.

The PEG ratio is defined as: (Price/ Earnings)/ Earnings Growth Rate

A lower PEG ratio is always better for value investors.

Why PEG over Others?

The commonly used metrics for finding value stocks include P/E (price-to-earnings), P/B (price-to-book value) or P/S (price-to-sales). As the PEG ratio is a little complicated involving a few more parameters, many investors don’t make use of it.

However, it gives a more complete picture of the future value of a stock, especially when compared to P/E. For value investors, considering PEG over P/E can be more rewarding as it helps in finding cheap stocks with future growth potential.

Here is an example for better understanding of the matter.

A company with a P/E ratio of 35 and a growth rate of 20% would have a PEG ratio of 1.75 (35 / 20 = 1.75) while a company with a P/E ratio of 40 and a growth rate of 50% would have a PEG ratio of 0.80 (40 / 50= 0.80).

If we only consider the P/E ratio, the second company with a lower P/E will obviously be in a better position (discounted state). But if we add the growth rate to justify the P/E, the scenario gets reversed.

However, PEG cannot perform magic alone; we need other relevant parameters to create a successful investment strategy. Let’s fine-tune the screening criteria to arrive at a winning combination.

Screening Criteria:

PEG Ratio less than X Industry Median

P/E Ratio (F1) less than X Industry Median

Zacks Rank #1 (Strong Buy) or #2 (Buy): Whether good market conditions or bad, stocks with a Zacks Rank #1 (Strong Buy) or #2 (Buy) have a proven history of success

Market Capitalization greater than $100 million: This ensures that the companies have strong liquidity)

Average 20 Day Volume greater than 20,000: A substantial trading volume ensures that the stock is easily tradable.

Percentage Change F1 Earnings Estimate Revisions (4 Weeks) greater than 5%: Upward estimate revisions add to the optimism, leading to stocks price appreciation.

Here are five of the 16 stocks that qualified the screening:

Yamana Gold, Inc. (AUY)

Antero Resources Corporation (AR)

CST Brands, Inc. (CST)

GAMCO Investors, Inc. (GBL)

Silicon Motion Technology Corp. (SIMO)

Get the rest of the stocks on the list and start putting this and other ideas to the test. It can all be done with the Research Wizard stock picking and back testing software.

The Research Wizard is a great place to begin. It's easy to use. Everything is in plain language. And it's very intuitive. Start your Research Wizard trial today. And the next time you read an economic report, open up the Research Wizard, plug your finds in, and see what gems come out.

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Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.

Disclosure: Performance information for Zacks’ portfolios and strategies are available at: http://www.zacks.com/performance.

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SILICON MOTION (SIMO): Free Stock Analysis Report
 
GAMCO INVESTORS (GBL): Free Stock Analysis Report
 
YAMANA GOLD INC (AUY): Free Stock Analysis Report
 
CST BRANDS INC (CST): Free Stock Analysis Report
 
ANTERO RESOURCE (AR): Free Stock Analysis Report
 
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